Special Committee on Aging,

U.S. Senate

United States General Accounting Office

GAO

For Release on Delivery

Expected at 2:00 p.m.

Monday, December 10, 2001 SOCIAL SECURITY

Issues in Evaluating

Reform Proposals

Statement of Barbara D. Bovbjerg, Director, Education,

Workforce, and Income Security Issues

GAO-02-288T
Page 1 GAO-02-288T

Mr. Chairman and Members of the Committee:

Thank you for inviting me here today as you continue the ongoing

discussion on how best to ensure the long-term viability of our nation’s

Social Security program.1

 Social Security not only represents the

foundation of our retirement income system; it also provides millions of

Americans with disability insurance and survivor’s benefits. As a result,

Social Security provides benefits that are critical to the current and future

well-being of tens of millions of Americans. However, as we have said in

congressional testimonies over the past several years,2

 the system faces

both solvency and sustainability challenges in the longer term. The

challenges of combating terrorism and otherwise addressing homeland

security have now come to the fore as new, unexpected, and urgent claims

on the federal budget. Still, none of the changes since September 11 have

lessened Social Security’s long-term pressures on the budget. In fact, the

events of September 11 have served to increase our long-range challenges.

Without reforms to Social Security and Medicare, these programs are

unsustainable, and their long-term impact on the federal budget and the

economy will be dramatic.

Over the past few years, a wide array of proposals have been put forth to

restore Social Security’s long-term solvency, and now a commission

appointed by the President is deliberating possible reform

recommendations. It is not my intention to take a position for or against

any individual reform proposal, element, or approach. Rather, I hope my

testimony today, which is based on a body of work we have published

over the past several years, will help clarify some of the key issues in the

debate.3

 To do that, I’m going to talk about the nature and timing of the

Social Security problem, a framework and criteria for evaluating reform

proposals, and findings from our recent report on Social Security’s role in

helping ensure income adequacy.4

 1

 Social Security refers here to the Old Age, Survivors, and Disability Insurance (OASDI)

program.

2 Social Security: Criteria for Evaluating Social Security Reform Proposals

(GAO/T-HEHS-99-94, Mar. 25, 1999); Social Security: The President’s Proposal

(GAO/T-HEHS/AIMD-00-43, Nov. 9, 1999); Long-Term Budget Issues: Moving from

Balancing the Budget to Balancing Fiscal Risk (GAO-01-385T, Feb. 6, 2001).

3

 See the list of related GAO products at the end of this statement.

4 Social Security: Program’s Role in Helping Ensure Income Adequacy (GAO-02-62, Nov.

30, 2001).
Page 2 GAO-02-288T

In summary, our Social Security challenge is more urgent than it may

appear and is part of a larger and significant fiscal and economic

challenge. The Social Security program, combined with rapid growth in

Medicare and Medicaid, will dominate the federal government’s future

fiscal outlook. Absent reform, the nation will ultimately have to choose

between persistent, escalating federal deficits, significant tax increases

and/or dramatic budget cuts; waiting only makes it harder. Although Social

Security’s Trust Funds will not be exhausted until 2038, according to the

latest trustees’ report’s intermediate projections,5

 the program’s cash

demands on the rest of the federal government will begin much sooner.6

Beginning in 2016, Social Security’s annual cash deficit will place

increasing pressure on the rest of the budget to raise the resources

necessary to meet the program’s ongoing costs—a pressure that will

continuously increase over time. Failure to take remedial action will, in

combination with other entitlement spending, place unsustainable

pressure on the government and, ultimately, the economy. Focusing on

trust fund solvency alone is not sufficient. We need to put the program on

a path toward sustainable solvency. Aiming for sustainable solvency

would increase the chance that future policymakers would not have to

face these difficult questions on a recurring basis. Moreover, while

addressing Social Security reform will not be easy, Medicare presents a

much greater, more complex, and urgent fiscal challenge.

Still, this problem is about more than finance. A comprehensive

framework for addressing the problem can help. To assist the Congress in

its deliberations, GAO has developed criteria for evaluating Social Security

reform proposals: financing sustainable solvency, balancing adequacy and

equity, and implementing and administering reforms. These criteria aim to

balance financial and economic considerations with benefit adequacy and

equity issues and the administrative challenges associated with various

proposals. The use of these criteria can help facilitate fair consideration

and informed debate of Social Security reform proposals. Reform

proposals should be evaluated as packages that strike a balance among

individual reform elements, and important interactive effects should be

 5

 For the annual report of the Board of Trustees for the Social Security Trust Funds, SSA

actuaries project future revenues and benefits. For these projections, they use alternative

assumptions regarding economic and demographic trends, including average earnings,

mortality, fertility, and immigration. The intermediate assumptions represent the board’s

best estimate of future trends.

6

 In this testimony, the term “Trust Funds” refers to the Old-Age and Survivors Insurance

and Disability Insurance Trust Funds.
Page 3 GAO-02-288T

considered. If we focus on the pros and cons of each element of reform, it

will be more difficult to build the bridges necessary to achieve consensus.

In addition, overall evaluation of each proposal depends on the weight

individual policymakers place on each criterion.

Finally, our recent report on Social Security and income adequacy

provides some specific insights on one of our criteria. First, no single

measure of adequacy provides a complete picture; each measure reflects a

different outlook on what adequacy means. So a variety of measures

should be considered. In addition, all adequacy measures depend

significantly on what types of income are counted. In particular, noncash

benefits such as Medicare play a major role in sustaining standards of

living for their beneficiaries. Any examination of income adequacy should

acknowledge the major role of noncash benefits and the needs they help

support. Second, given the currently projected long-term financial shortfall

of the program, it is important to compare proposals to both benefits at

currently promised levels and benefits funded at current tax levels. We

have developed benchmark policy scenarios to illustrate the range of

possible outcomes and used these benchmarks to examine the outlook for

income adequacy. However, since our report was focused on income

adequacy, it did not examine measures of individual equity, which should

be balanced against adequacy measures. Third, various approaches to

benefit reductions, in particular, would have differing effects on adequacy.

More progressive approaches to reducing monthly benefits would have a

smaller effect on poverty rates, for example, than less progressive

approaches. Also, reductions that preserve current law benefits for

survivors, disabled workers, and the very old would help minimize

reductions to income adequacy, though they could place other

beneficiaries at greater risk of poverty.

Today the Social Security program does not face an immediate crisis but

rather a long-range and more fundamental financing problem driven

largely by known demographic trends. The lack of an immediate solvency

crisis changes the challenge, but it does not eliminate the need for action.

Acting sooner rather than later would allow changes to be phased in so the

individuals who are most likely to be affected, namely younger and future

workers, will have time to adjust their retirement planning while helping

to avoid related “expectation gaps.” It is also important to put the overall

federal budget on a sustainable footing over the long term, thereby

promoting higher economic growth and more fiscal flexibility to finance

other priorities.

Social Security’s

Long-Term Financing

Problem Is More

Urgent Than It May

Appear
Page 4 GAO-02-288T

Since there is a great deal of confusion about Social Security’s current

financing arrangements and the nature of its long-term financing problem,

I’d like to spend some time describing the nature, timing, and extent of the

financing problem.

As you all know, Social Security has always been largely a pay-as-you-go

system. This means that current workers’ taxes pay current retirees’

benefits. As a result, the relative numbers of workers and beneficiaries

affect the program’s financial condition. This ratio, however, is changing:

today the ratio of workers paying Social Security taxes to beneficiaries is

3.4:1 and it is expected to drop to around 2:1 by 2030. The retirement of

the baby boom generation is not the only demographic challenge facing

the system. People are retiring early and living longer. A falling fertility

rate is the other principal factor underlying the growth in the elderly’s

share of the population. Taken together, these trends threaten the

financial solvency and sustainability of this important program.

(See fig. 1.)

Demographic Trends Drive

Social Security’s LongTerm Financing Problem
Page 5 GAO-02-288T

Figure 1: Ratio of Covered Workers to Beneficiaries

Note: Based on the intermediate assumptions of the 2001 OASDI Trustees’ Reports.

Source: GAO analysis of data from Office of the Chief Actuary, Social Security Administration (SSA).

The combination of these trends means that labor force growth will begin

to slow after 2010 and become negligible by 2025. (See fig. 2.) Relatively

fewer workers will be available to produce the goods and services that all

will consume. Without a major increase in productivity, low labor force

growth will inevitably lead to slower growth in the economy and, absent a

change in tax policy, to slower growth of federal revenues. This in turn

will only accentuate the overall pressure on the federal budget.

0

1

2

3

4

5

6

7

8

9

10

1955 1975 1995 2015 2035 2055 2075

Covered workers per OASDI beneficiary
Page 6 GAO-02-288T

Figure 2: Labor Force Growth Is Expected to be Negligible by 2050

Note: Based on the intermediate assumptions of the 2001 OASDI Trustees’ Reports.

Source: GAO analysis of data from Office of the Chief Actuary, SSA.

This slowing labor force growth is not always considered as part of the

Social Security debate. Fundamentally, there are only two ways to mitigate

the slowdown in labor force growth: keep people in the labor force longer

or bring in more people. Given longer life expectancies, improving health

status of older workers, economic needs, and budget realities, it may be

appropriate to consider finding ways to encourage people to work longer.

Social Security’s retirement ages are often the subject of discussion and

debate. It is also appropriate to consider whether and how changes in

pension and/or other government policies could encourage longer

workforce participation. To the extent that people choose to work longer

as they live longer, the finances of Social Security and Medicare would be

improved, and the expected slowdown in labor force growth might be

mitigated. However, in the case of Social Security, absent any new

increases in the full retirement age, any improvement could be offset to

some degree by the higher benefits that workers could have as a result of

delaying receipt of their benefits.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

1975 2000 2025 2050 2075

Percent change (5-year moving average)
Page 7 GAO-02-288T

Another key uncertainty is new entrants into the labor force. In domestic

social policy, we have seen an increasing focus on encouraging those

previously outside the labor force (such as welfare recipients and the

disabled) into the workforce. Concern about the slowdown in the labor

force may also lead to discussions about immigration and its role. These

are issues that the Congress may wish to explore further in the next few

years.

Because of these demographic trends, current estimates show that within

15 years benefit payments will begin to exceed program revenue, which is

composed largely of payroll taxes on current workers.7

 (See fig. 3.)

 7

 Income tax revenue resulting from taxation of up to 50 percent of Social Security benefits

for certain higher income beneficiaries is credited to the OASI and DI Trust Funds and

provided 2 percent of total income in 2000.
Page 8 GAO-02-288T

Figure 3: Social Security Income and Cost Rates

Note: Cost rates reflect the cost of Social Security benefits and other program costs as a percent of

taxable payroll, while income rates reflect payroll tax receipts and other program revenues as a

percent of taxable payroll. Projections based on intermediate assumptions of the 2001 OASDI

Trustees’ Report.

Source: Office of the Chief Actuary, Social Security Administration.

Within the federal budget, Social Security—more properly, the Old-Age

and Survivors Insurance and Disability Insurance programs (OASDI)—has

two trust funds that authorize Treasury to pay benefits as long as the

applicable trust fund has a positive balance. Currently, Social Security’s

cash income exceeds cash expenditures. The Trust Funds, by law, invest

the resulting surplus in U.S. government obligations or securities that are

backed by the full faith and credit of the U.S. government. At present, the

Trust Funds’ assets are in the form of special, nonmarketable Treasury

securities that are backed by the full faith and credit of the U.S.

Social Security Cash

Flows, Trust Funds, and

the Federal Budget

0

5

10

15

20

25

2000 2015 2030 2045 2060 2075

Income rate

Cost rate

Percent of taxable payroll
Page 9 GAO-02-288T

government and so carry no risk of default.8 Although the Trust Funds

cannot sell their holdings in the open market, the Trust Funds face no

liquidity or interest rate risk since it can redeem its special Treasury

securities before maturity at face value. These securities earn interest

credits at a statutory rate linked to market yields, and this interest from

the Treasury is credited to the Trust Funds in the form of additional

Treasury securities.

Social Security is included in the most commonly used measure of the

government’s financial balance, known as the unified budget

deficit/surplus. The unified budget measure includes all federal spending

and revenue. Between 1983 and 1998, surpluses in the Social Security trust

funds were used to partially offset a deficit in all other government

accounts within the unified budget.9 Since 1998 when the federal

government began running unified surpluses, some or all of the Social

Security surpluses have been used to reduce federal debt held by the

public.10

I think it is useful to pause for a moment here and reflect on what the term

“trust fund” means in the federal budget.11 Trust funds in the federal

budget are not like private trust funds. Individuals can create a private

trust fund using his or her own assets to benefit a stated individual(s). The

creator, or settlor, of the trust names a trustee who has a fiduciary

responsibility to manage the designated assets in accordance with the

stipulations of the trust. In contrast federal trust funds are budget

accounts used to record receipts and expenditures earmarked for specific

purposes. The Congress creates a federal trust fund in law and designates

 8

Under current law, the Secretary of the Treasury as trustee may purchase marketable

Treasury and agency securities if the Secretary determines that such purchase is “in the

public interest.” Such purchases have been rare. As of the end of fiscal year 2000, about

0.004 percent of OASDI trust fund holdings were in marketable Treasury securities.

9

 The interest credited to the trust fund does not currently affect the unified surplus or

deficit because it is an internal transaction of the government. One part of the government

(the Treasury) credits the interest to another part (the trust fund), so the two transactions

offset one another and there is no net budgetary effect.

10A portion of the Social Security surpluses offset an on-budget deficit in fiscal year 1998.

Fiscal year 1999 was the first year since 1960 that the federal government ran an on-budget

surplus.

11 For a discussion of trust funds and other earmarked funds in the budget, see Federal

Trust and Other Earmarked Funds: Answers to Frequently Asked Questions

(GAO-01-199SP, Jan. 2001).
Page 10 GAO-02-288T

a funding source to benefit stated groups or individuals. Unlike most

private trustees, the federal government can raise or lower future trust

fund collections and payments or change the purposes for which the

collections are used by changing existing laws. Moreover, the federal

government has custody and control of the funds, including the earnings

of most federal trust funds.

Under current law, when the Social Security Trust Funds’ receipts exceed

costs—that is, when the Trust Funds have an annual cash surplus—this

surplus is invested in Treasury securities and can be used to meet current

cash needs of the government or to reduce debt held by the public. In

either case, the solvency of the Trust Funds is unchanged. However, while

the Treasury securities are an asset to the Trust Funds, they are a liability

to the Treasury. Any increase in assets to the Trust Funds creates an

increase of equal size in future claims on the Treasury. One government

fund is lending to another. As a result, these transactions net out on the

government’s consolidated books.

While the accumulated balances in a trust fund reflect the government’s

commitment to pay benefits, limited to the assets held in the fund, they do

not in and of themselves increase the government’s ability to meet the

related program commitments. That is, simply increasing trust fund

balances does not improve program sustainability. Increases in trust fund

balances can strengthen the ability to pay future benefits if a trust fund’s

cash surpluses are used to improve the government’s overall fiscal

position. For example, when a trust fund’s cash surpluses are used to

reduce debt held by the public, this increases national saving, contributes

to higher economic growth over the long term, and enhances the

government’s ability to raise cash in the future to pay benefits. It also

reduces federal interest costs below what they otherwise would have

been, thereby promoting greater fiscal flexibility in the future.

The combined Social Security Trust Funds will be solvent through 2038

according to the Trustees’ intermediate estimates.12 However, our longterm model shows that well before that time program spending will

constitute a rapidly growing share of the budget and the economy.

Ultimately, the critical question is not how much a trust fund has in assets,

but whether the government as a whole can afford the promised benefits

now and in the future and at what cost to other claims on scarce

 12 Separately, the DI fund is projected to be exhausted in 2026 and the OASI fund in 2040.
Page 11 GAO-02-288T

resources. The future sustainability of programs is a key policy issue

policymakers should address—i.e. the capacity of the economy and budget

to afford the commitment. Fund solvency can help, but only if promoting

solvency improves the future sustainability of the program. General fund

transfers to the Trust Funds can improve solvency, but unless

accompanied by program reforms and/or reductions in debt held by the

public will have no effect on the program’s overall sustainability.

Today, the Social Security Trust Funds take in more in taxes than they

spend. Largely because of the known demographic trends I have

described, this situation will change. Under the Trustees’ intermediate

assumptions, combined program outlays begin to exceed program

revenues in 2016. At that time, the program will become a net claimant on

the rest of the federal budget. (See fig. 4.)

Social Security’s Cash

Flow Is Expected To Turn

Negative in 2016
Page 12 GAO-02-288T

Figure 4: Social Security’s Trust Funds Face Cash Deficits as Baby Boomers Retire

Note: Projections based on intermediate assumptions of The 2001 Annual Report of the Board of

Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds.

Source: GAO analysis of data from the Office of the Chief Actuary, Social Security Administration.

As I noted above, the special Treasury securities represent assets for the

Trust Funds but are future claims against the Treasury. To cover the cash

shortfall, —which is expected to grow— the Trust Funds will begin

drawing on the Treasury, first relying on its interest income and eventually

drawing down its accumulated trust fund assets. Regardless of whether

the Trust Funds are drawing on interest income or principal to make

benefit payments, the Treasury will need to obtain cash for those

redeemed securities either through increased taxes, spending cuts,

increased borrowing from the public, or correspondingly less debt

reduction than would have been the case had Social Security’s cash flow

-400

-300

-200

-100

0

100

200

2000 2005 2010 2015 2020 2025 2030 2035 2040

Cash surpluses Cash deficits

Social Security

cash deficit

2016

Billions of 2000 dollars
Page 13 GAO-02-288T

remained positive.13 The projected change in Social Security cash flow in

2016 will not mean a crisis in program financing: promised benefits will

continue to be paid in full. However, this negative cash flow will place

increased pressure on the federal budget to raise the resources necessary

to meet the program’s ongoing costs.

From the perspective of the federal budget and the economy, the expected

growth in Social Security spending is a major challenge in combination

with the even faster expected growth in Medicare and Medicaid spending.

This growth in spending on federal entitlements for retirees will become

increasingly unsustainable over the longer term, compounding an ongoing

decline in budgetary flexibility. Over the past few decades, spending on

mandatory programs has consumed an ever-increasing share of the federal

budget. For example, prior to the creation of the Medicare and Medicaid

programs, in 1962 mandatory spending accounted for about 33 percent of

total federal spending. By 2000, this share had more than doubled to

approximately 66 percent of the budget.

The Director of the Office of Management and Budget (OMB) has recently

suggested the possibility of federal budget deficits through fiscal year

2004, and other budget analysts appear to be in agreement. While we do

not know today what the 10-year budget projections will be in the next

updates by CBO and the Office of Management and Budget (OMB), we do

know the direction: they will be considerably less optimistic than before

September 11, and the long-term outlook will look correspondingly worse.

For example, if we assume that the 10-year surpluses CBO projected in

August are eliminated, by 2030 absent changes in the structure of Social

Security and Medicare, there would be virtually no room for any other

federal spending priorities, including national defense, education, and law

enforcement. (See fig. 5.) The resource demands that come from the

events of September 11—and the need to address the gaps these events

surfaced—will demand tough choices. Part of that response must be to

deal with the threats to our long-term fiscal health. Ultimately, restoring

our long-term fiscal flexibility will involve both promoting higher longterm economic growth and reforming the federal entitlement programs.

 13 If the unified budget is in surplus at this point, then financing benefits in excess of

dedicated tax revenue would result in less debt redemption rather than increased

borrowing.

Decline in Budgetary

Flexibility Will Be Severely

Exacerbated Absent

Entitlement Reform
Page 14 GAO-02-288T

When Congress returns for its next session, these issues should be placed

back on the national agenda.

Figure 5: August 2001 Projection – Composition of Federal Spending Under the “Eliminate Unified Surpluses” Simulation

Notes: Revenue as a share of GDP declines from its 2000 level of 20.6 percent due to unspecified

permanent policy actions. In this display, policy changes are allocated equally between revenue

reductions and spending increases.

Source: GAO’s August 2001 analysis.

Since Social Security will constitute claims on real resources in the future

when it redeems assets to pay benefits, taking action now to increase the

future pool of resources is important. As Federal Reserve Chairman

Greenspan has said, the crucial issue of saving in our economy relates to

our ability to build an adequate capital stock to produce enough goods and

services in the future to accommodate both retirees and workers in the

0

10

20

30

40

50

60

2000 2030 2050

Percent of GDP

Net interest Social Security Medicare & Medicaid All other spending

Revenue
Page 15 GAO-02-288T

future.14 The most direct way we can raise national saving is by increasing

government saving. Saving a good portion of the surpluses would allow

the federal government to reduce the debt overhang from past deficit

spending, provide a strong foundation for future economic growth and

enhance future budgetary flexibility.

Correspondingly, taking action now on Social Security not only would

promote increased budgetary flexibility in the future and stronger

economic growth but would also require less dramatic action than if we

wait. Perhaps the best way to show this is to compare what it would take

to achieve actuarial balance at different points in time. Figure 6 shows

this. If we did nothing until 2038—the year the Trust Funds are estimated

to be exhausted—achieving actuarial balance would require benefit

reductions of 30 percent or a tax increase of 39 percent.15 As figure 6

shows, earlier action shrinks the size of the necessary adjustment.

Figure 6: Changes Needed to Maintain Social Security Solvency

Note: The benefit reductions in this graph represent a one-time, permanent reduction to all existing

and future benefits beginning in the year indicated.

 14 Testimony before the Committee on Banking, House, and Urban Affairs, U. S. Senate,

July 24, 2001.

15 Based on estimates of program income from both the payroll tax and taxation of OASDI

benefits.

13

16

30

14

20

39

0

5

1 0

1 5

2 0

2 5

3 0

3 5

4 0

2001-2075 2016-2075 2038-2075

Benefit Reduction

 or

Tax Increase

Percentage
Page 16 GAO-02-288T

Source: GAO analysis of data from the intermediate assumptions of the 2001 OASDI Trustees

Report.

Thus both sustainability concerns and solvency considerations must drive

us to act sooner rather than later. Trust Fund exhaustion may be more

than 30 years away, but the squeeze on the federal budget is only 15 years

in our future. Actions taken today can ease both these pressures and the

pain of future actions. Acting sooner rather than later also provides a more

reasonable planning horizon for future retirees.

As important as financial stability may be for Social Security, it is not the

only consideration. Social Security remains the foundation of the nation’s

retirement system. Yet it is more than just a retirement program; it also

pays benefits to disabled workers and their dependents, spouses and

children of retired workers, and survivors of deceased workers. Last year,

Social Security paid almost $408 billion in benefits to more than 45 million

people. Since its inception, the program has successfully reduced poverty

among the elderly. In 1959, 35 percent of the elderly were poor. In 1999, 8

percent of beneficiaries aged 65 or older were poor, and 48 percent would

have been poor without Social Security. It is precisely because the

program is so deeply woven into the fabric of our nation that any proposed

reform must consider the program in its entirety, rather than one aspect

alone. Thus, GAO has developed a broad framework for evaluating reform

proposals that considers not only solvency but other aspects of the

program as well. Arguably, similar frameworks can also be applied to

other programs like Medicare.

The analytic framework GAO has developed to assess proposals

comprises three basic criteria:

• the extent to which a proposal achieves sustainable solvency and how

it would affect the economy and the federal budget;

• the relative balance struck between the goals of individual equity and

income adequacy; and

• how readily a proposal could be implemented, administered, and

explained to the public.

The weight that different policymakers may place on different criteria

would vary, depending on how they value different attributes. For

example, if offering individual choice and control is less important than

maintaining replacement rates for low-income workers, then a reform

proposal emphasizing adequacy considerations might be preferred. As

Evaluating Social

Security Reform

Proposals
Page 17 GAO-02-288T

they fashion a comprehensive proposal, however, policymakers will

ultimately have to balance the relative importance they place on each of

these criteria.

Any reforms to Social Security must ensure that program revenues

continue to exceed the cost of benefit payments if the Social Security

program is to achieve sustainable solvency. Historically, the program’s

solvency has generally been measured over a 75-year projection period. If

projected revenues equal projected outlays over this time horizon, then the

system is declared in actuarial balance. Unfortunately, this measure is

itself unstable. Each year, the 75-year actuarial period changes, and a year

with a surplus is replaced by a new 75th year that has a significant deficit.

This means that changes that restore solvency only for the 75-year period

will not hold. For example, if we were to raise payroll taxes by 1.86

percentage points of taxable payroll today—which, according to the 2001

Trustees Report, is the amount necessary to achieve 75-year balance—the

system would be out of balance next year. Reforms that lead to

sustainable solvency are those that avoid the automatic need to

periodically revisit this issue.

As I have already discussed, reducing the relative future burdens of Social

Security and health programs is essential to a sustainable budget policy for

the longer term. It is also critical if we are to avoid putting unsupportable

financial pressures on future workers. Reforming Social Security and

health programs is essential to reclaiming our future fiscal flexibility to

address other national priorities.

The current Social Security system’s benefit structure strikes a balance

between the goals of retirement income adequacy and individual equity.

From the beginning, benefits were set in a way that focused especially on

replacing some portion of workers’ pre-retirement earnings, and over time

other changes were made that were intended to enhance the program’s

role in helping ensure adequate incomes. Retirement income adequacy,

therefore, is addressed in part through the program’s progressive benefit

structure, providing proportionately larger benefits to lower earners and

certain household types, such as those with dependents. Individual equity

refers to the relationship between contributions made and benefits

received. This can be thought of as the rate of return on individual

contributions. Balancing these seemingly conflicting objectives through

the political process has resulted in the design of the current Social

Security program and should still be taken into account in any proposed

reforms.

Financing Sustainable

Solvency

Balancing Adequacy and

Equity
Page 18 GAO-02-288T

Policymakers could assess income adequacy, for example, by considering

the extent to which proposals ensure benefit levels that are adequate to

protect beneficiaries from poverty and ensure higher replacement rates for

low-income workers. In addition, policymakers could consider the impact

of proposed changes on various sub-populations, such as low-income

workers, women, minorities, and people with disabilities. Policymakers

could assess equity by considering the extent to which there are

reasonable returns on contributions at a reasonable level of risk to the

individual, improved intergenerational equity, and increased individual

choice and control. Differences in how various proposals balance each of

these goals will help determine which proposals will be acceptable to

policymakers and the public.

After I finish this brief overview of our evaluation framework, I would like

to come back to this criterion and share some results from our recent

report on income adequacy.

Program complexity can both make implementation and administration

more difficult, and make it harder to explain to the public. Some degree of

implementation and administrative complexity arises in virtually all

proposed reforms to Social Security, even those that make incremental

changes in the already existing structure. However, the greatest potential

implementation and administrative challenges are associated with

proposals that would create individual accounts. These include, for

example, issues concerning the management of the information and

money flow needed to maintain such a system, the degree of choice and

flexibility individuals would have over investment options and access to

their accounts, investment education and transitional efforts, and the

mechanisms that would be used to pay out benefits upon retirement.

There is also the necessary and complex task of harmonizing any system

of individual accounts with the extensive existing regulatory framework

governing our nation’s private pension system. In evaluating such

proposals, the complexities of meshing these systems would have to be

balanced against the opportunity of extending pension participation to

millions of uncovered workers.

Continued public acceptance and confidence in the Social Security

program require that any reforms and their implications for benefits be

well understood. This means that the American people must understand

what the reforms are, why they are needed, how they are to be

implemented and administered, and how they will affect their own

retirement income. All reform proposals will require some additional

Implementing and

Administering Proposed

Reforms
Page 19 GAO-02-288T

outreach to the public so that future beneficiaries can adjust their

retirement planning accordingly. The more transparent the

implementation and administration of reform, and the more carefully such

reform is phased in, the more likely it will be understood and accepted by

the American people. From a practical stand-point, the phase-in of any

reform should reflect individual fairness and political feasibility. With

regard to proposals that involve individual accounts, an essential

challenge would be to help the American people understand the

relationship between their individual accounts and traditional Social

Security benefits, thereby ensuring that we avoid any gap in expectations

about current or future benefits.

Over the past few years, we have been developing a capacity at GAO to

estimate the quantitative effects of Social Security reform on individuals.

Such estimates speak directly to applying our adequacy/equity criterion to

reform proposals. We have just issued a new report that includes such

estimates to illustrate the varying effects of different policy scenarios on

individuals.16 Today, I would like to share our findings regarding what

measures can be used to examine income adequacy, defining appropriate

benchmarks for assessing the future outlook for individuals’ Social

Security benefits, and how varying approaches to reducing benefits could

have different effects on adequacy. Our recent report did not, however,

present estimates of effects on individual equity.17 In addition to these

points, our report looked at how concern over income adequacy has

shaped the Social Security program over the years and how income

adequacy has changed over time, especially for different groups of

beneficiaries.

Various measures help examine different aspects of income adequacy, but

no single measure can provide a complete picture. Three examples

illustrate the variety of approaches.

 16 Social Security: Program’s Role in Helping Ensure Income Adequacy (GAO-02-62, Nov.

30, 2001).

17 For information on such issues, see Social Security: Issues in Comparing Rates of

Return with Market Investments (GAO/HEHS-99-110, Aug. 5, 1999).

Examining Effects of

Reform on Income

Adequacy

No Single Measure Gives

Complete Picture of

Income Adequacy
Page 20 GAO-02-288T

• Dependency rates measure what proportion of the population depends

on others for income support or, more specifically, on government

income support programs such as Supplemental Security Income (SSI).

Such rates reflect one of Social Security’s goals, reducing dependency

on public assistance, which was articulated very early in the program’s

history.

• Poverty rates measure what proportion of the population have incomes

below the official poverty threshold, which is just one of many

adequacy standards used in similar rate calculations. The poverty

threshold provides a minimal standard of adequacy; other standards

reflect different outlooks on what adequacy means.

• Earnings replacement rates measure the extent to which retirement

income replaces pre-retirement income for particular individuals and

thereby helps them maintain a pre-retirement standard of living. When

applied to Social Security benefits, this measure reflects the way the

benefit formula is designed to replace earnings.

For any of these measures, the meaning of a given value of the measure is

not clear. For example, what value of a dependency or poverty rate is

considered low enough and what replacement rate is considered high

enough are quite subjective. Moreover, all of these types of measures

depend significantly on what types of income are counted, such as beforeor after-tax income or noncash benefits such as Medicare and Medicaid.

As a result, the measures are most useful not for their estimated values in

isolation but rather for making comparisons, whether over time, across

different subpopulations, or across different policy scenarios.

In the past, we have pointed out the importance of establishing the proper

benchmarks against which reforms must be measured. Often reform

proposals are compared to currently promised benefits, but currently

promised benefits are not fully financed. It is also necessary to use a

benchmark of a fully financed system to fairly evaluate reform proposals.

To illustrate a full range of possible outcomes, our recent report on

income adequacy used hypothetical benchmark scenarios that would

restore 75-year solvency either by only increasing payroll taxes or by only

reducing benefits. Our tax-increase-only benchmark simulated benefits at

currently promised levels while our benefit-reduction-only benchmarks

simulated benefits funded at current tax levels. These benchmarks used

the program’s current benefit structure and the 2001 OASDI Trustees’

intermediate, or best-estimate, assumptions. The benefit reductions were

Benchmark Policy

Scenarios Illustrate Range

of Possible Outcomes
Page 21 GAO-02-288T

phased in between 2005 and 2035 to strike a balance between the size of

the incremental reductions each year and the size of the ultimate

reduction. At our request, SSA actuaries scored our benchmark policies

and determined the parameters for each that would achieve 75-year

solvency. For our benefit reduction scenarios, the actuaries determined

these parameters assuming that disabled and survivor benefits would be

reduced on the same basis as retired worker and dependent benefits. If

disabled and survivor benefits were not reduced at all, reductions in

retired worker benefits would be deeper than shown in this analysis.18

Future benefit levels and income adequacy will depend considerably on

how any benefit reductions are made. Figure 7 shows the percentage of

retired workers19 with Social Security benefits that fall below the official

poverty threshold for various benchmarks. Note that this graph does not

show poverty rates, which would require projections of total income;20

instead, it focuses only on Social Security benefits. The percentage with

total incomes below the poverty threshold would be lower if other forms

of retirement income were included. The figure shows that the percentage

with benefits below the poverty threshold would be greater under a

proportional benefit reduction than under a progressive benefit reduction.

The proportional benefit-reduction-only benchmark would reduce benefits

by the same proportion for all beneficiaries born in the same year. The

progressive benefit-reduction-only benchmark would reduce benefits by a

smaller proportion for lower earners and a higher proportion for higher

 18 See Social Security: Program’s Role in Helping Ensure Income Adequacy (GAO-02-62,

Nov. 30, 2001), appendix III, for more details on the alternative benefit reduction

benchmarks.

19 We used retired workers for simplicity. Our focus is on the difference between benefit

reduction approaches, holding everything else equal, and not on the type of beneficiary. We

use age 62 as the retirement age because most retired worker beneficiaries retire at that

age. Because of a variety of complexities concerning beneficiary and household type, our

estimates should not be interpreted as poverty rates. See Social Security: Program’s Role

in Helping Ensure Income Adequacy (GAO-02-62, Nov. 30, 2001), appendixes III and IV.

20 Given that our analysis examined only Social Security benefits and not total income, the

focus should not be on the specific estimates of adequacy measures but rather the

differences between them across types of measures, across beneficiary groups, and across

policy scenarios. . See Social Security: Program’s Role in Helping Ensure Income

Adequacy (GAO-02-62, Nov. 30, 2001).

Varying Approaches to

Benefit Reductions Would

Have Different Effects on

Adequacy
Page 22 GAO-02-288T

earners. The tax-increase-only (no benefit reduction) benchmark

estimates are shown for reference. 21

Figure 7: Adequacy of Income in Future Depends on Benefit Reduction Approach

(Retired Workers, All Retiring at Age 62)

Notes: The rates shown in the graph are not poverty rates because they reflect only Social Security

income, not total income. For the 1935 birth cohort, which reached age 62 in 1997, 51 percent of our

simulated sample had Social Security benefits below poverty. Under the proportional reduction

approach, all beneficiaries in a given birth year are subject to a benefit reduction that is a constant

proportion of their benefits. Under the progressive reduction, beneficiaries with lower benefits receive

a smaller proportional reduction than those with higher benefits. See appendix III in Social Security:

Program’s Role in Helping Ensure Income Adequacy (GAO-02-62, Nov. 30, 2001) for more details on

the alternative benefit reduction benchmarks.

Source: GAO’s analysis using the GEMINI model.

Different approaches to reducing benefits would have different effects on

income adequacy because their effects would vary with earnings levels.

Smaller reductions for lower earners, who are most at risk of poverty,

would decrease the chances that their benefits would fall below poverty.

 21 Figure 7 also shows that percentage of workers with benefits below the poverty

threshold would be slightly higher in our simulations for those retiring in 2032 rather than

2017. This reflects primarily that the benefit reductions in our benchmarks are more fully

phased in for the 2032 group than for the later group. The declines in the percentages from

the 2032 to 2047 retirement years largely reflects that initial benefit levels increase with

wages while the poverty threshold increases with prices, which are assumed to grow more

slowly than wages. Since the benefit reductions are fully phased in by 2035, the last two age

groups experience nearly the same benefit reductions.

29.7

31.8

24.6

28.5 29.5

22.4 21.8

17.5

11.5

0

5

10

15

20

25

30

35

1955 (2017) 1970 (2032) 1985 (2047)

Birth year (age 62 year)

Proportional reduction Progressive reduction Tax-increase only

Percent of cohort with Social Security benefits below poverty
Page 23 GAO-02-288T

Figure 8 illustrates how different approaches would have benefit

reductions that would vary by benefit levels (which are directly related to

earnings). The proportional benchmark would reduce benefits by an

identical percentage for all earnings levels. In contrast, the two alternative,

progressive benchmarks would reduce benefits less for lower earners than

for higher earners. The so-called “limited-proportional” benefit-reduction

benchmark would be even more progressive than the progressive benefitreduction benchmark because a portion of benefits below a certain level

are protected from any reductions while reductions above that level are

proportional.22 Moreover, different benefit reduction approaches would

have varying effects on different beneficiary groups according to the

variation in the typical earnings levels of those subgroups. For example,

women, minorities, and never married individuals all tend to have lower

lifetime earnings than men, whites, and married individuals, respectively.

Therefore, benefit reductions that favor lower earners would help

minimize adequacy reductions for such groups that typically have lower

earnings.

 22 The 1985 birth cohort will be subject to the largest benefit reductions of the four cohorts

we simulated; therefore, it best illustrates the potential disparity in benefit reductions by

benefit level.
Page 24 GAO-02-288T

Figure 8: Benefit Reduction Approaches Have Different Effects on Different Benefit

Levels (Retired Workers Born in 1985, All Retire at Age 62)

Notes: Quintiles are by benefit levels. Percentage reductions are calculated for beneficiaries closest

to the median of each quintile that appear in each scenario’s sample. For the 1985 birth cohort, all

benefit reductions are fully phased-in under our benchmark scenarios. Under the proportional

reduction approach, all beneficiaries in a given birth year are subject to a benefit reduction that is a

constant proportion of their benefits. Under the progressive reduction, beneficiaries with lower

benefits receive a smaller proportional reduction than those with higher benefits. Under the limited

proportional reduction, a portion of benefits below a certain level are protected from any reductions

while reductions above that level are proportional. See appendix III in Social Security: Program’s Role

in Helping Ensure Income Adequacy (GAO-02-62, Nov. 30, 2001) for more details on the alternative

benefit reduction benchmarks.

Source: GAO’s analysis using the GEMINI model.

As our report also showed, the effects of some reform options parallel

those of benefit reductions made through the benefit formula, and those

parallels provide insights into the distributional effects of those reform

options. For example, if workers were to retire at a given age, an increase

in Social Security’s full retirement age results in a reduction in monthly

benefits; moreover, that benefit reduction would be a proportional, not a

progressive reduction. Another example would be indexing the benefit

formula to prices instead of wages. Such a revision would also be a

proportional reduction, in effect, because all earnings levels would be

treated the same under such an approach. In addition, indexing the benefit

formula to prices would implicitly affect future poverty rates. Since the

official poverty threshold increases each year to reflect price increases

and benefits would also be indexed to prices, poverty rates would not be

expected to change notably, holding all else equal. In contrast, under the

24

16

11

24

21

23

24

23

28

24 25

31

24

30

32

0

5

10

15

20

25

30

35

Proportional reduction Progressive reduction Limited proportional

reduction

Lowest quintile Second Third Fourth Highest quintile

Percentage reduction in Social Security benefits
Page 25 GAO-02-288T

current benefit formula, initial benefit levels would grow faster on average

than the poverty threshold and poverty rates would fall, assuming that

wages increase faster than prices on average, as the Social Security

trustees’ report assumes they will.

Changes to the Social Security system should be made sooner rather than

later—both because earlier action yields the highest fiscal dividends for

the federal budget and because it provides a longer period for future

beneficiaries to make adjustments in their own planning. The events of

September 11 and the need to respond to them do not change this. It

remains true that the longer we wait to take action on the programs

driving long-term deficits, the more painful and difficult the choices will

become.

Today I have described GAO’s three basic criteria against which Social

Security reform proposals may be measured: financing sustainable

solvency, balancing adequacy and equity, and implementing and

administering reforms. These may not be the same criteria every analyst

would suggest, and certainly how policymakers weight the various

elements may vary. But if comprehensive proposals are evaluated as to (1)

their financing and economic effects, (2) their effects on individuals, and

(3) their feasibility, we will have a good foundation for devising agreeable

solutions, perhaps not in every detail, but as an overall reform package

that will meet the most important of our objectives.

Our recent report on Social Security and income adequacy showed that

more progressive approaches to reducing monthly benefits would have a

smaller effect on poverty, for example, than less progressive approaches.

Also, reductions that protect benefits for survivors, disabled workers, and

the very old would help minimize reductions to income adequacy, though

they would place other beneficiaries at greater risk of poverty. More

broadly, the choices the Congress will make to restore Social Security’s

long-term solvency and sustainability will critically determine the

distributional effects of the program, both within and across generations.

In turn, those distributional effects will determine how well Social

Security continues to help ensure income adequacy across the population.

Still, such adequacy effects then need to be balanced against an

assessment of the effects on individual equity. In addition, all adequacy

measures depend significantly on what types of income are counted. In

particular, noncash benefits such as Medicare play a major role in

sustaining standards of living for their beneficiaries. Any examination of

Conclusion
Page 26 GAO-02-288T

income adequacy should acknowledge the major role of noncash benefits

and the needs they help support.

In finding ways to restore Social Security’s long-term solvency and

sustainability, the Congress will address a key question, whether explicitly

or implicitly:

What purpose does it want Social Security to serve in the future?

• to minimize the need for means-tested public assistance programs;

• to minimize poverty; using what standard of poverty;

• to replace pre-retirement earnings;

• to maintain a certain standard of living; or

• to preserve purchasing power?

The answer to this question will help identify which measures of income

adequacy are most relevant to examine. It will also help focus how options

for reform should be shaped and evaluated. Our work has illustrated how

the future outlook depends on both the measures used and the shape of

reform. While the Congress must ultimately define Social Security’s

purpose, our work has provided tools that inform its deliberations.

Still, Social Security is only one part of a much larger picture. Reform

proposals should be evaluated as packages that strike a balance among

their component parts. Furthermore, Social Security is only one source of

income and only one of several programs that help support the standard of

living of our retired and disabled populations. All sources of income and

all of these programs should be considered together in confronting the

demographic challenges we face. In addition to Social Security, employersponsored pensions, individual savings, Medicare, employer-provided

health benefits, earnings from continued employment, and means-tested

programs such as SSI and Medicaid all should be considered, along with

any interactions among them. In particular, compared to addressing our

long-range health care financing problem, reforming Social Security is

easy lifting. We at GAO look forward to continuing to work with this

Committee and the Congress in addressing these important issues.

Mr. Chairman, members of the Committee, that concludes my statement.

I’d be happy to answer any questions you may have.
Page 27 GAO-02-288T

For information regarding this testimony, please contact me at

(202) 512-7215. Individuals making key contributions to this testimony

include Ken Stockbridge, Charles Jeszeck, Alicia Cackley, Jay McTigue,

Linda Baker, and Melissa Wolf.

GAO Contact and

Staff

Acknowledgments
Page 28 GAO-02-288T

Social Security: Program’s Role in Helping Ensure Income Adequacy

(GAO-02-62, Nov. 30, 2001).

Social Security Reform: Potential Effects on SSA’s Disability Programs

and Beneficiaries (GAO-01-35, Jan. 24, 2001).

Social Security Reform: Evaluation of the Nick Smith Proposal.

(GAO-AIMD/HEHS-00-102R, Feb. 29, 2000).

Social Security Reform: Evaluation of the Gramm Proposal

(GAO/AIMD/HEHS-00-71R, Feb. 1, 2000).

Social Security Reform: Information on the Archer-Shaw Proposal

(GAO/AIMD/HEHS-00-56, Jan. 18, 2000).

Social Security: The President’s Proposal (GAO/T-HEHS/AIMD-00-43,

Nov. 9, 1999).

Social Security: Evaluating Reform Proposals (GAO/AIMD/HEHS-00-29,

Nov. 4, 1999).

Social Security Reform: Implications of Raising the Retirement Age

(GAO/HEHS-99-112, Aug. 27, 1999).

Social Security: Issues in Comparing Rates of Return With Market

Investments (GAO/HEHS-99-110, Aug. 5, 1999).

Social Security: Implications of Private Annuities for Individual

Accounts (GAO/HEHS-99-160, July 30, 1999).

Social Security: Capital Markets and Educational Issues Associated with

Individual Accounts (GAO/GGD-99-115, June 28, 1999).

Social Security Reform: Administrative Costs for Individual Accounts

Depend on System Design (GAO/HEHS-99-131, June 18, 1999).

Social Security Reform: Implementation Issues for Individual Accounts

(GAO/HEHS-99-122, June 18, 1999).

Social Security: Criteria for Evaluating Social Security Reform

Proposals (GAO/T-HEHS-99-94, Mar. 25, 1999).

Related GAO Products
Page 29 GAO-02-288T

Social Security: Individual Accounts as an Element of Long-Term

Financing Reform (GAO/T-HEHS-99-86, Mar. 16, 1999).

Social Security: Different Approaches for Addressing Program Solvency

(GAO/HEHS-98-33, July 22, 1998).

Social Security Financing: Implications of Government Stock Investing

for the Trust Fund, the Federal Budget, and the Economy

(GAO/AIMD/HEHS-98-74, Apr. 22, 1998).

Social Security: Restoring Long-Term Solvency Will Require Difficult

Choices (GAO/T-HEHS-98-95, Feb. 10, 1998).

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